Currency pegs

Poor dollar standard

Has the downgrade shaken loyalty to the greenback?

“THE United States can pay any debt it has because we can always print money to do that,” said Alan Greenspan, a former chairman of the Federal Reserve, after Standard & Poor's cut America's credit rating. Whenever this point is made, people usually respond by invoking Zimbabwe. As the hapless African republic demonstrated, there is a limit to how much money a government can print before its economy plunges into hyperinflation.

But Zimbabwe no longer has hyperinflation. According to the Economist Intelligence Unit, a sister company of The Economist, inflation will average only 5.5% this year. How did it achieve this miracle? By adopting the American dollar as its principal currency. America may have lost its triple-A rating, but the dollars it issues will “remain the key international reserve currency under any plausible scenario,” says John Chambers of Standard & Poor's.

Zimbabwe is one of 66 countries beside America itself that, by the IMF's last count, either adopt the dollar as legal tender, peg their currency to it or manage their exchange rate against it. Its only present rival, the euro, has a much smaller circle of influence, counting 25 devotees, beyond the 17 members of the euro zone itself (see chart).

The 66 members of the dollar block have a collective GDP of almost $9 trillion, or about 14% of the world economy. The list includes some minnows like St Kitts and Nevis, some populous countries like Bangladesh and some middle-ranking economic powers like Saudi Arabia. The group comprises allies such as Qatar, and rebels such as Venezuela, which expresses disdain for American imperialism even as it surrenders its monetary sovereignty to America's central bank.

Alas, all is not well in the dollar block. Last year, inflation averaged 5.6% across its members (without weighting for GDP). This year it will probably rise to almost 8%.

The biggest member of the dollar block by far is China, which keeps tight tabs on the yuan's movements against the greenback. It has aspirations to create its own reserve currency. Many countries already keep an eye on the yuan because they cannot afford to lose competitiveness against a formidable exporter. An analysis by three economists at the National Institute of Public Finance and Policy in Delhi shows that the yuan already has a discernible influence on as many as 33 currencies.

One economy sandwiched between the dollar block and a potential yuan block is Hong Kong. Its dollar peg, backed by a currency board, made perfect sense when the yuan was also tied to the greenback. But as the yuan parts company with the dollar, Hong Kong feels pulled in two directions. Some have called for the yuan to be recognised as legal tender alongside the Hong Kong dollar. But Hong Kong officials tend to keep quiet about the whole issue. They fret that to discuss alternatives to the dollar peg is to undermine confidence in it. The link to the dollar has “served Hong Kong very well as the anchor for monetary and financial stability since 1983,” said Norman Chan, head of the Hong Kong Monetary Authority, after the S&P downgrade.

That loyalty to the dollar cannot be assumed, even in the places where it is most deserved. On August 10th Newsday, a Zimbabwean newspaper, wondered whether it was time for Zimbabwe to “ditch” the dollar, lest it import America's macroeconomic recklessness. Some think the South African rand would provide a better alternative. The dollar remains the world's key currency, but it cannot be a good sign that even some Zimbabweans are now considering alternatives.